How Much to Risk When Trading Stocks, Futures and Options

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Position size is key in trading and investing. There’s a funny (and true) statement on Wall Street: When you’re right, you never own enough. When you’re wrong, you own too much.

That seems to be the reality of it, too.

However, if you can make position size more systematic, you can have a better chance at consistency regardless of whether you’re a trader or an investor (or both). In Part 1, we talked about how large a position should be in regards to how much risk a particular trade carries.

(We also included a free position size calculator you can tinker with!)

However, due to the length of the article, we decided to break it up into two parts. This second part is shorter, but focuses more on the total trade size vs. your account value.

In our last story, the lesson was pretty straightforward. If you were looking to risk X, then all you had to do was calculate your entry price and stop-less, then multiply.

Here’s why that’s only part of the equation though.

Position Sizing for Your Account

Say you have a $100,000 account and are looking to risk just 1% of the account on a particular trade. Say it’s Apple (AAPL) and you’re looking to buy at $145 with a stop-loss at $143.

Okay, that’s pretty simple stuff.

• $100,000 times 1% risk equals $1,000.

• Risk equals $1,000

• Entry ($145) minus stop-loss ($143) equals $2.

• Total risk ($1,000) / $2 (risk per share) equals 500 shares.

In this scenario, we can buy 500 shares of Apple and risk $2 per share.

However, we’re failing to account for the “unknown” in this case. For instance, 500 shares of Apple at $145 represents $72,500 — or 72.5% of our account value!

The trading environment matters here.

If we’re in a trending bull market with low volatility, we can get away with a larger overall position size. However, if we’re in a choppy market or a bear market with elevated volatility, we have to take that into consideration.

Further, we have to take timeframe into consideration.

Are we day-trading AAPL in this scenario and will be in-and-out in a matter of minutes or hours? That drastically lowers the risk vs. swing trading this name for days or weeks at a time.

Because our stop-loss is well-defined, timeframe must be considered here. It’s much easier to stop-out at $143 if it happens 90 minutes after entry. It’s harder if we hold for days or weeks at a time when the position size is too large relative to our account.

If we go back to our example for a moment, what happens if Apple gaps down by 10% and we’re carrying a full position?

That 10% loss equates to $7,250 or more than 7% of our account!

Lastly, we must consider the instrument. There’s a big difference trading Apple or Microsoft (MSFT) and trading a low-volume, small cap stock.

My Personal Mistake With Improper Position Size

You might be sitting here thinking, “Yeah, but what are the odds that Apple gaps down 10% overnight?”

Apple is a great company and I don’t know the odds, but I know that’s exactly what happened to me.

On January 3rd, 2019, Apple opened lower by roughly 9% and closed lower by 10% after the firm pre-announced disappointing quarterly results. Guess who had a large overnight swing position in Apple? Yep, me!

Common stock owners were burned. Short-term call option owners saw their positions wiped out overnight. No one thought it would happen to a well-capitalized blue-chip stock like Apple.

I was humbled and about a month later, I had all but recouped those losses. I was swing trading Boeing (BA), which had pulled back nicely to support after recently hitting all-time highs. This was February 2019. The next morning, shares opened lower by about 12% after a Boeing 737 MAX operated by Ethiopian Airlines crashed.

After years without hard rules in regards to overall position size — I always considered the overall size, but didn’t have hard-and-fast rules for it — I had been burned in back-to-back months. Essentially, all of my first-quarter trading profits went toward offsetting two big losers.

That said, I learned my lesson!

Bottom Line on Position Sizing

Most swing traders will limit the overall position to 10% to 20% of their overall account value. That said, every trading strategy and every trader is different.

Position size for a day trader will be much different than that of a swing trader. It will also matter greatly what you are trading.

In the context of a low-volatility environment, swinging the SPY should have lower volatility than an individual stock like Netflix (NFLX).

Amazon (AMZN) will be more volatile than something like Johnson & Johnson (JNJ).

You get the point.

Position sizing basically boils down to three things: When (environment), what (stock or instrument) and how (timeframe).